I am having a hard time figuring out if I should hold onto my rental property or sell it. I am what you call the accidental landlord. I converted my condo into a rental back in Oct 2011. The value at conversion was 200K.

I bought the condo at 222,000 and currently owe the bank 188,000 on this. If I sell the property now, I will probably be able to sell it for 200K and break even after clearing mortgage, real estate commissions, fees etc.

For the 2011 and 2012 years I have taken 1500+7200= 8900 depreciation.

When I did my taxes for 2012, I am at a negative 7000 on this property which I used to offset my regular income as I manage my property actively.

Is it Income - Mortgage Interest - Expenses? I just about break even if that's the case.

Or do I count the entire mortgage payments I made totaling 14000 in which case my cash flow is -4000. How do I even factor in depreciation into cash flow?

My questions are basically around if the home prices rise only 1-2% every year for the next 10 years and rents go little higher up, does it make sense to hold onto the property or sell it? Should I take any steps to improve cash flow like refinance or increase rent. Or is it pointless cause my numbers are very bad?

I am not averse to landlording as such. Also, the condo is in a good location with very few things that can break and exterior maintenance is taken care of by the condo association. That being said, I don't want to hold onto the property if I will only make a very small profit 10 years from now. Question is, how are my numbers looking?

Well, you're loosing money on it which doesn't seem like much of an investment. I wouldn't factor in the depreciation since you'll have to recapture that back when you sell the property, so it's more of a shift of tax liability from one year to another. Unless your taxable income varies a lot and you need certain losses or depreciation to offset other income/investments (which gets complicated to analyze) there doesn't seem to be much advantage.

If you were to go out today and buy a rental, you wouldn't buy one based on the current numbers. You would probably put, say $100k down, in attempt to realize positive cash flow on the $100k investment that was better than investing in something else.

You could make the cash flow positive by paying off the mortgage. But what does that really change? In my mind, nothing. I recall listening to a man named Bob Brinker many years ago who said what I have always tended to think. He viewed returns on a rental property as cash on cash. If you are an accidental landlord and intrinsically aren't into that business, I would sell regardless of cash flow and be free of the headaches.

2) If you sold it for a loss would you be able to claim a capital loss and deduct it on your taxes.

3) Do you have too much real estate exposure compared to your net worth? For example if you bought a $300K house when you moved out then combined you have around $500K in real estate exposure. In your net worth is $400K then you have 125% of your net worth in real estate which would not make me feel very comfortable.

I am very confused on the best way to compute cash flow.

Is it Income - Mortgage Interest - Expenses? I just about break even if that's the case.

Or do I count the entire mortgage payments I made totaling 14000 in which case my cash flow is -4000. How do I even factor in depreciation into cash flow?

You are mixing up cash flow with profit or loss. A simple way to figure cash flow is to have a separate checking account for everything related to the Condo. If you deposit the rent checks in that and pay all expenses, including taxes, out of that and the account grows or shrinks then you know if your cash flow is positive or negative.

The profitability is more complex because it considers the things like depreciation and paying down the mortage some each month.

1) What is your time worth?
I have a day job but am free evenings and weekends, ample time to manage the rental.

2) If you sold it for a loss would you be able to claim a capital loss and deduct it on your taxes.
I believe so. I have to research IRS publications. Although the fact that I reduced the value from 222K to 200K when putting it up for rental may create a gain instead of a loss if I end up selling between those 2 figures.

MNFinance: Well, you're loosing money on it which doesn't seem like much of an investment.
Watty: You are mixing up cash flow with profit or loss. A simple way to figure cash flow is to have a separate checking account for everything related to the Condo. If you deposit the rent checks in that and pay all expenses, including taxes, out of that and the account grows or shrinks then you know if your cash flow is positive or negative.

So I guess I am seeking more clarification around above points. I will not be losing money if I refinance and improve cash flow, correct? Does that make it a good investment in that case? Or am I already doomed because I bough the rental at a high price in the first place? I guess I am wondering, would a savvy investor purchase and maintain this property at the numbers given?

NOTE: Here you do include profitability, but not mortgage principal payments. This is how the IRS figures profit or loss when you do your taxes. You can make a good argument that you shouldn't include depreciation here.

To correctly value this against another investment, you should not consider depreciation (exception below).

You need to look at cash flow-- interest payments come in here.

Divide the cash flow by the market value of the asset (ie not what you paid for it, not worrying about mortgage v. equity) and that gives you your return, that you can (taking after tax cash flows) benchmark against other investments.

As a reminder, you want to do all this after tax.

Properly, you should do a discounted cash flow. Figure out the cash flow for however long you plan to hold the investment, and a terminal value, ie the sale value (net of all costs). You would do this without taking into account interest paid.

Then discount back. The formula =IRR (using the cost of the investment as a negative in the first cell) in Excel will give you the %pa return from holding the investment.

If you just want to consider the investment *from now* then use the current *net* market value of the investment as the cash outflow ie it's the opportunity cost of this investment vs. another one you could make. But net of all sale proceeds.

Depreciation, not being a cash cost is irrelevant EXCEPTION if I understand US tax rules, you take depreciation on the property that increases your taxes payable at sale. So that is how depreciation becomes a cash flow (ie only at sale).

In order to evaluate this as an investment, I would calculate the capitalization rate (cap rate), which is the gross rents less non-financing expenses divided by the purchase price (including closing costs). You should include the following in your estimate of non-financing expenses:

I can probably improve my profitability by $1500 or so by increasing rents but the numbers still look bad overall. I guess its best I sell for a loss and target more liquid investments.

It really depends on how long you intend to hold this, and what sales price you might reasonably expect.

What I do know is the US housing market has tightened by a lot in the last 12-18 months-- some big price moves, and the biggest moves in some of the worst hit cities. See Calculated Risk blog for excellent tracking of US housing market economics.

I think generally unless one wants to build a landlord one should get out of it-- there's too much hassle and risk. And US fiscal-political issues are casting a dark cloud over things (especially for DC area) BUT that said, it might be worth revisiting this in a year's time.

So few homes have been built in the last few years that if and when US returns to normal, it will be racing to catch up.